Markets Finish Week Slightly Lower Despite Strong Start to Earnings Season

WEEKLY MARKET UPDATE – July 22, 2019

Markets finished the week lower despite a relatively strong start to earnings season. So far, 16% of the companies in the S&P 500 have reported Q2 2019 earnings results. Of the companies that have reported, 79% have exceeded expectations. Notably, most major US banks surprised analysts as strong loan growth and a low level of credit losses point to a healthy economy. While earnings were expected to decline 3% year-over-year heading into the season, the initial wave of positive reports has caused analysts to project a roughly flat quarter of growth now.

As major indices dipped lower, gold continued to shine during the week. Gold prices climbed as over $1,450/oz for the first time since 2013 amid expectations of lower interest rates. Comments from New York Fed President John Williams bolstered the potential for a July rate cut as he said: “it’s better to take preventative measures than to wait for disaster to unfold.” Since the beginning of May, gold prices have rallied over 9% as lower potential rates and global uncertainties have made the metal an attractive inflation and risk hedge.

This week was a great example of how markets can disassociate from underlying fundamentals. However, over the long-run, fundamental conditions tend to drive the direction of the markets. This is why it is important to remain committed to a plan and maintain a well-diversified portfolio. Flashy news headlines can make it tempting to make knee-jerk decisions, but sticking to a strategy and maintaining a portfolio consistent with your goals and risk tolerance can lead to a better probability for long-term success. Including a broad mixture of asset classes can help with achieving more consistent long-term results, smoothing the short-term market noise and making it easier to weather market fluctuations.

Chart of the Week

The S&P 500 is still sitting near all-time highs, despite experiencing the largest weekly decline since the end of May. As the Index climbs to record levels, the price-to-earnings ratio is subsequently rising. Currently, stocks appear overvalued as the 12-month forward P/E ratio is at 17.0. This is above the 5-year average of 16.5 and above the 10-year average of 14.8. For US stocks to continue to rally in a healthy manner, earnings would have to increase.

*Chart source: Bloomberg

Market Update

Equities

Broad equity markets finished the week negative while international stocks fared better than domestic stocks. S&P 500 sectors were mostly negative, with defensive sectors outperforming cyclical sectors.

So far in 2019, technology and consumer discretionary stocks are the strongest performers while healthcare has been the worst-performing sector.

Commodities

Commodities were negative for the week as oil prices decreased by 7.61% to $55.63/bl. This is the largest weekly decline since the week of May 26th as US crude inventories continue to rise. However, by week-end, prices slightly clawed back as Iran claimed it had seized a British oil tanker. Tensions between the US and Iran have continued to rise ever since the US imposed sanctions on the Arab nation and would not renew temporary waivers to their biggest oil importers. Additionally, last weeks retreat in oil prices shows markets are not ready for prices above $60/bl as the commodity has not been able to sustain prices above that level since early May.

Gold prices rose by 0.61%, closing the week at $1,426.30/oz as some volatility returned to the markets by weeks end. Additionally, ever since the latest Fed minutes, markets have effectively priced in a rate cut for July, with some pricing in a 50 basis point cut. Since gold is US dollar-denominated, lower interest rates make the dollar weaker, ultimately making it cheaper for foreign investors to purchase the metal. Gold also acts as a safe haven asset class in times of uncertainty. As geopolitical risks persist and fundamentals appear slightly overvalued, investors have been purchasing the metal to hedge against uncertainty. Currently, gold prices sit near a 6-year high as the current economic environment has helped foster additional price increases.

Bonds

The 10-year Treasury yield fell from 2.12% to 2.05%, resulting in positive performance for traditional US bond asset classes. Yields fell as comments from New York Fed President John Williams reinforced the belief that the Fed will cut rates in July. However, on the economic side, the recent inflation reading came in above 2% providing conflicting signals in what economic data is telling us compared to what the Fed is actually planning on doing.  Currently, the probability of rate cut sits at 100% for July.

High-yield bonds were negative for the week as riskier asset classes fell and credit spreads widened. However, as long as US economic fundamentals remain healthy, higher-yielding bonds have the potential to experience further gains in the long-run as the risk of default is still moderately low.

Asset class indices are positive so far in 2019, with large-cap US stocks leading the way and aggregate bonds lagging behind.

Lesson to be Learned

We do the worst possible thing at the worst possible time because we are most certain that we are right just when we are most likely to be wrong.”

– Jason Zweig

Investors often cost themselves money because of irrational short-term behavior. When exuberance or fear set in people tend to act on emotions, leading them to make decisions at the worst time. The best way to avoid this irrational behavior is to implement a plan with predefined steps to take ahead of time. If you stick with a plan and maintain a properly diversified portfolio, you increase your chances for a successful investment outcome in the long-run.

FormulaFolios Indicators

FormulaFolios has two simple indicators we share that help you see how the economy is doing (we call this the Recession Probability Index, or RPI), as well as if the US Stock Market is strong (bull) or weak (bear).

In a nutshell, we want the RPI to be low on the scale of 1 to 100.  For the US Equity Bull/Bear indicator, we want it to read at least 66.67% bullish. When those two things occur, our research shows market performance is the strongest and least volatile.

The Recession Probability Index (RPI) has a current reading of 29.19, forecasting further economic growth and not warning of a recession at this time. The Bull/Bear indicator is currently 100% bullish – 0% bearish, meaning the indicator shows there is a slightly higher than average likelihood of stock market increases in the near term (within the next 18 months).

The Week Ahead

Investors will continue watching results from Q2 earnings season as markets gear up for a July 31 Fed announcement.

More to come soon.  Stay tuned.